According to Start-Up Britain, eighty businesses are started every hour in the UK alone, and the number of entrepreneurs is on the rise worldwide. With competition this fierce, small and medium-sized companies need outside funding to get established and expand. With the emergence of alternative funding over the past decade, their options for accessing this funding have fundamentally changed.
Banks Used to Have a Monopoly Funding
Before the 2008 financial crisis, banks were the go-to source of small business funding. However, the crisis and its aftermath have exacerbated challenging lending conditions for SMEs.
Many applicants for loans do not fit bank requirements (26% of applications were rejected in the UK in 2015, according to the British Business Bank), and when they are approved for a loan, the terms—time-consuming checks and high interest rates—can be as difficult as not receiving funding at all. Unable to compete with large firms with quick access to funding, many start-ups and small businesses have been stifled under these conditions.
Fintech Creates New Possibilities
Fortunately, traditional banks loans are no longer the only option. The development of innovative financial technology (fintech), from quick and secure payments networks to online credit score checkers, has destroyed barriers and connected SMEs directly to lenders.
The past decade’s advances in fintech, along with social media, have given rise to two forms of financing now essential for many entrepreneurs, crowdfunding and peer-to-peer lending, as well as new avenues for existing options such as angel investing and venture capital.
Crowdfunding Raises Funds While Testing the Market
The largest crowdfunding platforms were all started in the past decade, with rewards-based platforms Indiegogo and Kickstarter launched in 2008 and 2009 and equity-based platforms Crowdcube and Fundable in 2011 and 2012. Niche platforms for sectors such as film and real estate are creating an even simpler way to connect entrepreneurs with the right finance providers.
While young, crowdfunding is already a big business. From 2012 to 2015, the global crowdfunding volume increased from $2.7 billion (£2 billion) to 34.4 billion (£26.2 billion), according to CrowdExpert.com. This growth hasn’t slowed down: from 2015 to 2017, equity crowdfunding alone increased by 295%, from £84 million to £332 million in the UK. In a City A.M. article, crowdfunding leaders predicted that financing by this route will only increase in the years to come.
Another trend is the increase in crowdfunding campaigns doubling as marketing campaigns, which helps businesses validate their products by proving market demand for them, tweaking their products in response to consumer feedback. Some companies, such as the Pebble Technology Corporation, have chosen crowdfunding with the primary aim of utilising its potential for low-cost publicity. The company’s smartwatch product surpassed its funding goal within 24 hours, but it was the coverage the campaign received on social and traditional media that made it a record-breaking success.
Notable examples of crowdfunding platforms are Crowdcube and Syndicate Room.
Peer-to-Peer Lending Offers a New Form of Debt-Based Funding
Peer-to-peer (P2P) lending, essentially a debt-based form of crowdfunding, began with the UK platform Zopa in 2005. Now, in 2017, P2P platforms provide billions in loans to smaller businesses by connecting them directly to lenders.
When bank loans became less available to SMEs during the financial crisis of 2008, P2P platforms stepped in to offer the same capital, but with lower interest rates, greater accessibility, and greater returns for investors. At the same time, innovation in fintech created a more efficient lending process that banks feared they could not compete with. Once viewed as a niche, P2P lending platforms have become a viable alternative to banks—and may eventually rival them.
Notable examples of crowdfunding platforms are Funding Circle and Market Invoice.
Business Angels and Venture Capitalists Make More and Bigger Deals
Angel and venture capital investment offers entrepreneurs more than capital. The investors will often support a startup from seed to growth stage, providing mentoring and guidance as business partners.
Overall, angel and venture capital investments in SMEs have shown a strong increase over the past 10 years. In the UK, equity investing has grown 205% by number and 179% by value between 2011 and 2015, with a slight drop in 2016. This trend gave some of today’s most successful companies, including SpaceX, Snapchat, and Uber, the financial start they needed to thrive.
Notable examples of crowdfunding platforms are Angel Investment Network and Calculus Capital.
The Start of a New Era?
Even after this decade of disruption, banks are still the most common option for SME funding, and, according to a Deloitte report, peer-to-peer lending is unlikely to eliminate banks as institutional middlemen. However, according to the British Business Bank, the trends discussed in this article toward competition and innovation in SME financing are pressuring banks to offer funding to more SMEs, on better terms and giving entrepreneurs options for securing quick funding.
While many SME owners, especially those outside of large cities, still believe that the bank is their only option, awareness of the other routes is increasing. More and more entrepreneurs are realising that there have never been options for financing their start-ups and expansions.
Want to learn more and meet some of the notable providers mentioned here? Come to The Business Funding Show’s Investment Conference on 15 November 2017. Speakers and agenda can be found here.
Book your ticket now.